Australia | Jun 24 2008
By Greg Peel
When an explosion occurred at the Apache Energy-owned gas facility on Varanus island, off the coast of Western Australia, it was news. But not particularly hold-the-front-page stuff. There was an immediate assessment that gas supply would be cut for several days, and that mining operations relying on Varanus as a power source would need to temporarily switch to alternative sources, such as diesel.
That was on June 3. But over the month the realisation grew that the facility would not reopen in a matter of days, nor even weeks. Supply could be cut off for a matter of months. This is a facility that supplies WA with 30% of its gas. Soon the ramifications began to dawn.
As a result, the WA premier has now asked his citizens to please ration their power. 60% of the state’s electricity is produced using gas. The world nickel price shot up when Minara Resources announced major production cutbacks, as did BHP Billiton. The share price of Babcock & Brown Power fell in (another) heap as the company slashed its earnings forecast. Newcrest has announced production cutbacks at its Telfer gold mine. The big Pilbara iron ore miners are watching closely. A WA Chamber of Commerce survey has now found that 14% of WA businesses have been forced to shut down production altogether. Another 50% suggested drastic cuts would ensue, to an average of 64% of production lost.
This was no small explosion.
As Standard Chartered suggests, Varanus cannot compare to the Chinese earthquake, or the American mid-west floods, as far as diasters are concerned. However, despite its lack of scale on the disaster front, the Varanus explosion could well have economic consequences that are proportionately larger. WA only accounts for 14% of the national GDP, but it currently accounts for over half of Australia’s mining output and over one-third of its exports.
Standard Chartered economists now believe the explosion could effectively wipe as much as a full percentage point off Australia’s second half GDP, with the greatest impact concentrated in the third quarter. As a result, they have reduced their economic growth forecast for 2008 from 2.3% to 1.7%.
Not only is this disaster manifest, the analysts note, but it could not have come at a much worse time. The Australian economy has begun to show signs of turning down rather dramatically, and it seemed the only thing holding it back from a possible recession was the strength of the mining boom and commodity demand. Retail sales have dropped in three of the last four months, May saw the first job losses in 18 months, corporate investment fell 2.5% in the first quarter, and surveys suggest business confidence is at historical lows.
The only sector to show a jump of any significance in the first quarter GDP measure was non-dwelling construction. The problem is, 50% of that construction is going on in WA. Without sufficient energy, that near-term growth outlook could suffer a severe blow.
Standard Chartered notes that they, too, have been caught out by the sudden recent jump in energy prices, which is feeding inflation. This new “supply shock” is only going to make matters worse in the short term. In the medium term, the impact to WA internal demand, as the state deals with energy rationing, will also be material. In the fourth quarter of 07, WA demand grew by 9.5% against the national average of 5.3%.
Inflation is the RBA’s greatest fear. Part of the bank’s hawkish stance against inflation is based on its belief that Australia’s improving terms of trade – driven by high commodity prices and increasing production – will keep demand growth pushing along at too high a level. However, since Varanus that terms of trade improvement assumption may well have gone out the window.
As a result, Standard Chartered has altered its forecast – now believing that the RBA will cut not once, but twice before 2008 is out, for a total of 50 basis points.
The economists also have a rather ominous warning. While the financial spill-over of this disaster may not seem threatening at first, consider that Australia has seemed relatively immune from housing slumps and major loan default accelerations on a national average basis. That is because the commodity states such as WA have distorted the numbers. “Should the eventual dislocation reach a scale as to jeopardize broad credit and liquidity conditions,” suggests Standard Chartered, “that will clearly give a reason for the central bank to jump into remedial action sooner and deeper than our current forecast.”